The leaves are starting to change color, and there is a slight chill in the air. This can only mean one thing… Not only is it Fall, but it is also projection season! We are now in the last quarter of the year, which is a prime time to sit down with your tax professional to review and plan your taxes for the current year. This can help avoid surprises and penalties next year. One of the topics of discussion may be charitable contributions.
The Basics of Charitable Contributions
Charitable contributions are one popular tax savings tool that comes up frequently during the year-end review and planning process. Charitable contributions are a unique deduction because they have two benefits: they save you money on taxes and they help those in need. While we would never encourage benevolence simply for the tax benefits, if you are ordinarily a giving person, the tax savings are an added perk.
If you itemize your deductions, you’re able to include any and all charitable contributions you gave during the tax year. As a reminder, you will itemize if your applicable deductions are more than $13,850 in 2023 ($27,700 for married taxpayers). Even if you don’t typically itemize, but you are a regular charitable giver, it might be worth considering bunching your charitable contributions. This means you could donate two years’ worth of donations (or more) in one taxable year, making it much more likely that you would have enough expenses to itemize.
Charitable contributions can be cash or non-cash items.
Here are some things to keep in mind as you make charitable contributions:
- Not all charities are created equal. Be sure to verify your recipient charity is a qualified 501(c)(3) organization. Charitable deductions are NOT allowed for any other individual or organization. (So no, your $50 GoFundMe donation to your neighbor’s dog’s surgery, while virtuous, is not tax deductible.) You can utilize the IRS’s tax exempt organization search tool to verify a qualified charity.
- If the donation is more than $250, you’ll need to have written acknowledgement for your records from the recipient charity. It must contain the following information, according to the IRS website:
- name of the organization;
- amount of cash contribution; or
- description (but not value) of non-cash contribution;
- statement that no goods or services were provided by the organization, if that is the case;
- description and good faith estimate of the value of goods or services, if any, that organization provided in return for the contribution; and
- statement that goods or services, if any, that the organization provided in return for the contribution consisted entirely of intangible religious benefits, if that was the case.
- If the donation was a non-cash item and valued at more than $5,000 (excluding publicly traded securities), you will need a qualified appraisal to substantiate the value you are claiming on your tax return.
- Generally, if you donate non-cash items, including stock, you are required to report the cost basis of the donated item on your return. Be sure to note this information when you make your donation to save time while preparing your return.
- Want to make a large donation but not sure to which organization(s) you want to donate? Consider a donor advised fund (DAF). It is a separate, charitable account that you can set up and contribute cash, securities, appreciated assets, etc.to the account. You are able to claim a tax deduction in the year you make these contributions. Then you can distribute the funds to the charities of choice at your leisure. Most brokerage accounts offer them.
A smart tax savings opportunity is donating stock, especially if you have a lot of stock options. Donating stock options helps lower your tax bill, diversifies your portfolio, and benefits the charity of your choosing.
The value of the donation that you can claim depends on how long you hold the stock. For restricted stock, the holding period begins on the day the stock vests. For NQSOs, ISOs or ESPPs, then the holding period begins when you exercise or purchase the stock.
If you hold the stock for at least a year before donating it, you are able to claim the value of the stock on the day you donate it.
If you donate stock that was held for less than a year, the value you can claim on your return is the lower of your cost basis or the fair market value of the stock on the day it was donated.
Special Rules for Certain Stock
There are special nuances to be aware of if you intend to donate ESPPs or ISOs. It is possible to trigger a disqualifying disposition of the stock if you donate it before you have satisfied the holding period. This holding period is two years from the grant date and one year from the exercise or purchase date. If you do donate ESPPs or ISOs before meeting the holding period, then you will need to report compensation income equal to the spread between the exercise/purchase price and the fair market value of the stock on the date of exercise/purchase.
If the ISO or ESPP that you donate is not held for a year after exercise or purchase, then your charitable deduction amount is equal to the adjusted cost basis of the stock. (This includes the cost of the stock at exercise/purchase plus any compensation income you recognized as a result of the disqualifying disposition.) However, this amount cannot exceed the fair market value of the stock on the donation date. If the stock drops in value since you acquired it, your charitable deduction will be limited to its current value.
Ivy exercised ISOs on April 1, 2023. The stock’s fair market value was $20 on the exercise date, and Ivy paid $10/share to exercise 100 shares. On December 1, 2023, Ivy donated all 100 shares to a qualified charity when the stock’s value was $15/share. Ivy recognizes $1,000 in compensation from the disqualifying disposition. As a result, Ivy’s adjusted cost basis in the donated stock is $2,000. However, Ivy’s charitable contribution deduction would only be $1,500.
Say you hold onto your ESPP or ISO stock for over a year, but you have not yet held it for two years since its grant, then you can claim a deduction equal to the stock’s value on the date of donation (while also recognizing compensation income as outlined above).
Assuming similar facts as above, except Ivy holds the stock until April 2, 2024 when it is worth $30/share. She was granted the stock in December 2022. Ivy will still recognize $1,000 in compensation income, but she will also claim a $3,000 charitable contribution deduction.
Special Note for Section 423 ESPPs
Section 423 ESPPs are tax qualified. Which means you can purchase stock at a discount without owing tax on the discount at the time of purchase. Even if you satisfy the holding period for these ESPPs, you will still recognize ordinary income equal to the discount from the offering price when you donate the stock.
Special Note on AMT for ISOs
What happens to your AMT you incurred from the exercise of your ISOs? You may question if donating stock will trigger a negative AMT adjustment, but the answer is no. Instead, you will continue to hold onto your AMT credit and carry it forward until it is used up.
There are a few strategies to keep in mind as you look to make charitable contributions this year, whether it is stock, cash or other non-cash items.
For stock that you have held for at least a year, it is most advantageous to donate the stock directly to the charity instead of selling the stock and donating the cash proceeds to the charity. This helps you avoid capital gains taxes on the proceeds of the sale.
For stock that’s dropped in value, it’s better to sell the stock first to take advantage of tax-loss harvesting. You can then donate the cash proceeds to charity.
Do you have a stock that is performing really well with a promising outlook, but you still wish to make a stock donation? Consider donating the stock to charity, then buying the same stock again after donating. This helps you avoid capital gains taxes on the transferred stock. It also helps establish a higher basis in the stock should you decide to sell it in the future.
Consider higher charitable contributions in a high income year if you can swing it. Did you sell some real estate at a large gain or receive a windfall in stock options? You can donate some of the proceeds of these transactions to help offset your overall tax liability.
Connect with your tax professional today to review your unique circumstances to see what other tax planning opportunities you can utilize this year.